Paulson challenged on execution of bailouts

Banks were treated with kid gloves, University of Chicago finance professor tells former Treasury secretary

February 25, 2010|By Greg Burns

It's an article of faith among the business and government elite that bailing out Wall Street prevented another Great Depression.

America had to do it, the thinking goes, to avoid a much worse fate.

How much worse? Try unemployment at 25 percent, not 10 percent. Try millions cast out of their homes, not hundreds of thousands. Try years of depression and pain for everyone, rather than recession and pain for many.

Few deliver this message with more conviction than Henry Paulson, the former Goldman Sachs Group Inc. chief who did as much as anyone to engineer the bailouts while serving as Treasury Secretary under George W. Bush.

Touting his new memoir, "On the Brink," at the University of Chicago this week, Paulson said that by propping up the financial system, the government bailouts averted catastrophe.

Without the government bailing out mortgage giants Fannie Mae and Freddie Mac, disaster would have followed, he said.

Without a bailout for insurer-turned-hedge-fund American International Group Inc.? Disaster.

Without a Troubled Asset Relief Program for the banks? Disaster.

In 2008, America stood only "hours away from an absolute collapse," Paulson said. "If a bank fails, the ultimate victims are going to be the citizens. This was done for the American people."

Yet the message never got through to the American people, Paulson said. Had he been a better public speaker, he said, more Americans would see the bailout his way: It was unpleasant but necessary, and maybe even heroic.

"So much of this is communication," he said.

In other words, many Americans just don't get it.

Funny, but the guy who shared the dais with him thinks Paulson doesn't get it.

Miscommunication has nothing to do with public rage over the bailouts, said Raghuram Rajan, finance professor at the University of Chicago's Booth School of Business.

Main Street, Rajan said, sees all too clearly how Paulson and the rest went easy on their fellow bankers while preserving a status quo that had made them rich.

Remember when the Goldmans and Citigroups were desperate for help in the midst of the panic, and government responded by guaranteeing their debt and raising deposit-insurance limits? That was the moment when Paulson and his fellow policymakers failed to make their peers on Wall Street share the pain, Rajan said.

"They could have used that to get much better practices. Throughout the crisis, they treated the banks with kid gloves," Rajan said. "The public anticipated what we see now: Tons of money being made by the banks again."

What could have been done instead? Letting all the chips fall would have been a mistake, worsening the panic, Rajan said.

But when the banks had nowhere else to turn, government should have insisted on cutting cash compensation, shutting off dividends, imposing losses on certain debt contracts and making bailed-out institutions pay for their recapitalization over time, Rajan said, adding that taxpayers should have received a bigger share of the upside as well.

Taking those steps would have discouraged Wall Street from relying on another bailout for the next time everything goes wrong. They also would have helped Uncle Sam extract commitments from the industry for improved regulation down the line.

But of course it didn't happen. And now Paulson is pushing belatedly for Congress to create a single systemic-risk regulator and approve "resolution authority" to wind down failed institutions in an orderly manner.

At the same time, as Paulson observed, Congress tends to act only in a crisis.

Considering that the latest crisis has passed, it stands to reason that anyone serious about financial reform might have to wait for the next one.